Geller Law
A useful analogy from the CFA Institute:
The primary purpose of the risk-profiling process is to ensure that investment and financial recommendations match an investor’s financial and emotional aptitude to engage in financial transactions, at the household level, that entail financial/investment risk.
We begin by presuming that a financial advisor collects necessary objective and behavioral information from and about an investor with the intention of making investment recommendations that are always in the investor’s best interests and that align with the investor’s IRP. When viewed from this perspective, the use of an IRP is analogous to deciding how fast to drive a car:
• Before embarking, a driver makes a mathematical estimate of how long the journey will take, and thus how fast she or he needs to drive to arrive at the appointed time.
• At the same time, the driver applies subjective probabilities to assess the severity and consequences of arriving late.
• Along the way, the driver faces limitations with respect to how fast her car can actually go; this ability factor is equivalent to a regulatory speed limit, the amount of fuel the car has, and the traffic conditions the driver encounters.
• Finally, the driver’s behavioral preferences come into play; some drivers, for instance, get a thrill out of driving aggressively, regardless of the possible consequences of being pulled over by law enforcement or getting in an accident, whereas others prefer a more cautious journey.
Each of these elements—need, ability, and behavioral loss tolerance—plays a distinct role in shaping how fast someone drives. One factor alone is insufficient to predict a trip’s characteristics. The combination of driver, car, and environmental characteristics is what shapes the driving profile of each trip. Similarly, multiple factors must be combined in the development of an IRP.
